Competitive Devaluation

Everyone and his brother thinks that the US$ is going down. When so many people
are in one side of the trade, it's important to examine the case for the other
side. This is especially true for silver investors, as the Dollar is the global
accounting unit for precious metals and commodities.

When one discusses the Dollar's stance, it's important to remember: "with respect
to what?" For Example, is Dollar in a bearish stance with respect to gold, silver,
Yen, Euro, or oil, etc.?

There are at least several reasons why US$ may rise against other fiat
currencies.

First, the Dollar Index level at 80, a 20-year low support level, is
strong enough such that it won't be significantly crossed without a serious
fight. (Long-term Dollar Index chart, DecisionPoint format is available in Brian
Bloom's most recent article, "Paranioa."
Richard Russell also showed the same chart in his mid-November Dow Theory Letter
issue.) Markets are mischievous. The Dollar may actually go down below 80 a
bit only to claim the largest possible number of speculative shorts before turning
around for a rally.

Moreover, trade deficits may not have as large an impact on the Dollar as
many economists believed. Consider the following alternative theory… The
US manufactures produce the highest margin products. The trade deficit is
a measure of revenue not profit margin. Economists have thus far tend to
discard the measure of profit margin among the macro variables. Therefore, while
the US runs a large trade deficits to its trading partners, the US runs a large
profit margin surplus to other countries. This theory is courtesy of Andy
Kessler, and explained extensively in his book Running
Money.

OK. If you don't like that, at least one has to agree with Kessler that in
the short-term (and possibly medium-term), his theory is maybe right. The problem
is in the long-run. This "long-run" basically means that other countries have
caught up with the US in the technological lead. It means that other countries
have so much R&D and intellectual property that they can manufacture products
or provide services with profit margins that exceed the US. And excel the US
in many high-tech products and services, not just a few. The "long-run"
may take quite a few years and possibly even decades.

And lastly (also the most important) the demographically-driven debt problem,
in the long-run, maybe worse in many other countries than the US. Consider the
following two sets of data supplied by Professor Laurence Kotlikoff and Scott
Burns' book, The
Coming Generational Storm (highly recommended):

The Aging World and Population Decline (population in millions)

Country or area

2000

2025

2050

% older than 60 in 2050

United States

283.2

346.8

397.1

26.9

More developed regions

1191.4

1218.8

1181.1

33.5

Europe

727.3

683.5

603.3

36.6

France

59.2

62.7

61.8

32.7

Germany

82

78.9

70.8

38.1

Italy

57.5

52.4

43

42.3

Russia

145.5

125.7

104.3

37.2

Japan

127.1

123.8

109.2

42.3

China

1275.1

1470.8

1462.1

29.9

And

The Decrepit Quarter

High Life expectancy (76.9), low birth (1.5) Most of Europe,
Japan, China

Panglossian Balance

High life expectancy (73.4), low birthrate (2.1) United
States

Postmodern Malthusian Hell

Low life expectancy (58.0), low birthrate (1.4) Russia,
most states of former Soviet Union

Traditional Malthusian Hell

Low life expectancy (52.3), high birthrate (4.9) Most of
Africa, other undeveloped nations

So, Panglossian Balance. The US is actually one of the bests among a bad lot!

Competitive Devaluation

The purpose of this article is not to advise you to go long the US Dollar.
Rather, it's to argue that the Dollar's decline relative to other paper fiat
currencies maybe over.

However, the last point mentioned above, the demographically-drive debt problem,
is very real and severe for many countries in the world on an absolute scale;
even though US is in relatively better shape than other industrialized
nations. There are three possible ways for political leaders (and central bankers)
to "manage" away this debt problem: increase taxes, cut benefits, and seigniorage
(or the inflation tax through currency debasement). An honest politician would
probably tell, or attempt to tell, the truths. An honest politician would probably
attempt to raise taxes and/or cut benefits. An honest politician would also
probably try to avoid seigniorage as much as possible since such process, unlike
the more transparent tax increases and benefit cuts, is a bit like stealing.

Have you ever met an honest politician? I know a few. And they soon convert
from honest to dishonest politician. Power corrupts.

So given the political reality, the best managerial strategy is to postpone
the inevitable debt problem as far into the future as possible. Preferably until
the politicians have retired. Having this goal in mind, inflation is the best
way to go; and, hence, the most likely outcome.

One country after another rushing to collect seigniorage through currency debasement
results in competitive devaluation.

One more point. While trade deficits don't matter, trade issues matter.
Drums of protectionism may grow louder as the industrial nations' economies
remain in the doldrums. China's Yuan-peg is needed for China to economically
develop itself out of a third world nation's condition. In the same time, China's
peg is inviting trade criticism from the US and Europe. And other Asian nations,
competing against the Chinese on export basis, cannot afford too much currency
appreciation. As US Dollar depreciates, it puts further pressure on Europe to
talk down Euro.

Given the existence of WTO and the possibility that events may not play out
exactly as the history, competitive devaluation may materialize as a venting
venue of global protectionism sentiment. This is in contrast to the ‘Thirties.
Back then, countries were raising tariffs one after another.

Conclusion

We are likely entering a period of competitive devaluation, practiced by the
global central bankers and politicians, with the following long-term
implications for investors:

Gold and silver are likely to continue their long-term bull markets as
they are "natural" currencies that cannot be debased.

Commodities, due to their intrinsic values, can keep going up in the long-term
as well.

Paper fiats will likely enter a volatile period, with "commodities-based
currencies" more capable of holding value. Thus, Australian, New Zealand,
and Canadian Dollars are likely to rise in the long-run.

The long-term relative performance of stocks, bonds, and cash are likely
to be ugly, uglier, and ugliest respectively.

So 2005 maybe the first year that we are seeing precious metals and commodities
prices divorcing from the paper fiats.

DISCLAIMER: The author is not a registered stockbroker
nor a registered advisor and does not give investment advice. His comments
are an expression of opinion only and should not be construed in any manner
whatsoever as recommendations to buy or sell a stock, option, future, bond,
commodity or any other financial instrument at any time. While he believes
his statements to be true, they always depend on the reliability of his own
credible sources. Of course, the author recommends that you consult with a
qualified investment advisor, one licensed by appropriate regulatory agencies
in your legal jurisdiction, before making any investment decisions, and barring
that, we encourage you confirm the facts on your own before making important
investment commitments.